In most cultures, calling someone mature isn’t considered an insult. Among investors, however, calling a company mature is the equivalent of saying it’s a has-been. And conventional wisdom says that the surest sign of maturity is when a company starts paying a dividend.
That conventional wisdom is reinforced these days by investor fascination with the FANG stocks, Facebook, Amazon, Netflix, and Google. (Now that Google has created a parent company called Alphabet, maybe we should call this group FANA.) None of these issues pays a dividend.
All four are considered technology companies, even though Amazon and Netflix are technically in the consumer discretionary sector. Tech issues aren’t supposed to pay dividends, right? Although widely believed, that has never been true: IBM has paid a dividend every quarter since 1916. Today, 64% of the stocks in the S&P 500 information technology sector pay a dividend.
Okay, so tech stocks can pay dividends, but the ones that do are no longer growing, right? Not necessarily.
Among dividend payers in the S&P 500 tech sector, 21 including EMC, Intel, Oracle and Texas Instruments have net income growth rates of 10% or better. It’s worth noting that only two of the four FANGs, Facebook and Alphabet (Google) have five-year net income growth rates above 10%. Both Amazon and Netflix are given passes by growth investors because they are building out their businesses for future profits.
It’s worth remembering the old Wall Street adage that trees don’t grow to the sky. The saying refers to stock prices, but it is also true of earnings. If your clients want to know why, try this grammar school math demonstration. Ask if they would rather have $1 million or the end product of one cent doubled every day for a month. Many people will choose the million, not realizing that compounding turns that penny into $10.7 million after 30 days. The same compounding principle explains why Facebook’s 43.5% net income growth rate will not persist.
Investors’ desire for growth stocks is nothing new. In the 1960s, the favorites were a group known as the “nifty fifty.” Advisors with long memories might recall that the nifty fifty included Eastman Kodak, Polaroid and Sears. The point is that growth slows, and in some cases stops. Polaroid, unable to adapt to a world no longer interested in instant photography, endured two bankruptcies and went out of business. Kodak, late to the digital photography revolution, is a shadow of its former self. And Sears, once the world’s largest retailer, is not the first choice of most shoppers.
Companies that are still growing and also provide their shareholders dividends offer the best of both worlds. Growth doesn’t have to end because a company has decided it’s time to pay a dividend. Consider the four mature tech stocks cited above. EMC is 37 years old and growing 20%. Intel is 47 and growing almost 22%. Oracle was established 38 years ago and has net income growth of 10%. And senior citizen Texas Instruments is 65 years old and growing net income at close to 14%.
Many growth stock fans own shares simply because their price is rising. But that can change quickly as some have discovered in the recent market turbulence. The paper profits are not real until you book them. And you could miss your chance in a rapid market selloff.
In contrast, once a dividend is paid, it’s yours to keep. Even if the market dips, you still have your cash payment as part owner of a public company. You might say that for some investors, owning dividend payers is a sign of maturity.
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